Indian Banks Feel the Heat

Non-performing assets are on the rise at Indian banks, and the situation is only likely to get worse as they restructure debt.

Indian banks’ non-performing assets are on the rise. The sector is feeling the effects of slowing economic growth, a tight monetary policy regime, and the stalling of big-ticket investments.

At the end of last financial year, gross non-performing assets in the Indian banking system were close to 3% (of gross advance), the highest in six years, Reserve Bank of India data show. The trend has worsened this year.

Advertisement

As of Sept. 30, the gross non-performing assets of Indian banks rose by nearly 46% (530 billion rupees, or roughly $10 billion) from a year earlier, says a study by NPAsource.com. Gross advances – total advances made by the banking sector – grew by less than 16% in the same period. If non-performing assets rise faster than advances, the profitability of banks declines.

Fitch Ratings has warned that the gross non-performing assets of the Indian banking system will be as high as 4.2% of advances this financial year. That would be the highest since 2004-05, when the ratio stood at 5.2%. Rising non-performing assets lead to higher provisioning requirements for banks. This impacts banks’ profitability and also their capital adequacy ratio, restricting their ability to grow.

High inflation and interest rates in conjunction with falling demand have hurt the profit margins and cash flow of companies, and they are finding it tough to service their debt. And debt-restructuring is now on the rise, meaning non-performing assets could expand.

With restructured loans, lenders dilute the terms under which the loans were initially sanctioned. This could involve lowering the interest rate and extending the tenure.

Under India’s Corporate Debt Restructuring scheme, banks can restructure loans jointly. When an interest payment is overdue for three consecutive months, the outstanding loan gets classified as a non-performing asset.

Since April, Indian banks have been required to report their non-performing assets in a new computerized system. Available data show that nearly 90% of Indian banks’ loan portfolios are under the computerized system, which has helped cut out window-dressing as bank managers no longer have the discretion to classify assets.

As a result, there is a greater probability of a loan being classified as non-performing, leading to a spike in non-performing asset figures. But bank managers can still collude with lenders and coax them to make payment for a month within the three-month period and thereby prevent the loan from being classified as a non-performing asset.

As of Dec. 31, the total amount of loans (on a cumulative basis) restructured by Indian banks under the corporate debt restructuring mechanism was 2.12 trillion rupees, an increase of 245.84 billion rupees from the start of October.

Not all restructured loans end up as non-performing assets, but at least a quarter have the potential. As the economy struggles to gather steam, credit conditions worsen and companies find it difficult to raise cash from the stock markets, the probability of default increases.

For banks, restructuring leads to increased cost of credit as they need to set aside a higher percentage of the original loan amount. The provisioning requirement for a loan is around 0.4%, but it goes up to 2% for a restructured loan. Last week, the RBI issued a draft guideline on lifting provisioning on newly restructured loans to 5% from April 1.

Most restructured loans belong to sectors like power, telecom and textiles, which are seen as relatively risky in India. Many big power projects are stuck at the implementation stage while smaller power producers are finding it difficult to repay loans as state electricity boards are unable to pay them. Textile companies are witnessing a slowdown in demand, and the telecom sector faces high spectrum charges, intense competition and the fallout of the 2G license scandal. The RBI says that these three sectors accounted for more than 30% of banks’ total outstanding loans of as of November.

Most restructured loans belong to state-owned banks. The Finance Ministry said in September that state banks would restructure textile loans worth 350 billion rupees. In the same month, the Cabinet Committee on Economic Affairs approved restructuring of loans worth 1.9 trillion rupees to the ailing state electricity boards.

Forced debt restructuring of many loss-making public sector companies is a practice that allows bankers to classify non-performing loans as standard, thereby increasing the risk of impairment of assets in the future.

Addressing industries’ problems by restructuring loans comes at the cost of the health of the banking sector, especially state-owned lenders more prone to arm-twisting. As the provisioning requirement increases, state-owned banks need to be recapitalized at a faster pace

Banks may be allowed to raise capital from the market, but that would dilute the government’s holding of these banks. Such a move would be met with political opposition. And raising money from the market would mean further stress on government finances as the cost of borrowing far exceeds the return.

The best solution is for the government to gradually reduce its stakes in state-owned banks. That would generate revenue for the government and improve the operational efficiency of banks. Politically, any loss of control would be met with resistance, but until such a thing happens, the banking sector and economy will continue to face challenges.

The author is an economist based in New Delhi. These are his personal views.

About India Real Time

India Real Time offers analysis and insights into the broad range of developments in business, markets, the economy, politics, culture, sports, and entertainment that take place every single day in the world’s largest democracy. Regular posts from Wall Street Journal and Dow Jones Newswires reporters around the country provide a unique take on the main stories in the news, shed light on what else mattered and why, and give global readers a snapshot of what Indians have been talking about all week. You can contact the editors at indiarealtime(at)wsj(dot)com.